Business context and reporting period
Innodata Inc. provides digital content, information technology and professional services through Content Services (CS) and Innodata Advanced Data Solutions (IADS). This unaudited Form 10-Q covers the three months ended March 31, 2014; comparisons are with the three months ended March 31, 2013 unless otherwise noted. Amounts below are in U.S. dollars.
Financial results and liquidity
| Metric | Q1 2014 | Q1 2013 or comparison |
|---|---|---|
| Revenue | $14.1 million | $16.9 million; down 17% |
| Direct operating costs | $10.3 million; 73% of revenue | $12.8 million; 76% of revenue |
| Gross margin, calculated as revenue less direct costs | 26.8% | 24.3% |
| Selling and administrative expenses | $3.8 million; 27% of revenue | $4.6 million; 27% of revenue |
| Loss before income taxes | $5,000 | $372,000 loss |
| Consolidated net income (loss) | $106,000 loss | $103,000 income |
| Net income attributable to Innodata | $189,000; $0.01 per share | $316,000; $0.01 per share |
| Cash from operating activities | $4.3 million | $3.1 million |
CS revenue was $14.0 million, down about 14%; IADS revenue was $72,000, versus $635,000. CS reported approximately $1.4 million of segment income after intersegment eliminations, while IADS reported a $1.4 million loss. The consolidated net loss differs from parent-attributable net income because the filing reports $295,000 of losses attributable to non-controlling interests.
At March 31, 2014, cash and cash equivalents were $29.2 million, working capital was $30.2 million, total assets were $52.3 million and stockholders’ equity was $40.9 million. Cash increased $4.4 million during the quarter. Operating cash flow benefited substantially from $3.4 million of net collections of accounts receivable; capital expenditures were $767,000. DSO was approximately 65 days, compared with 74 days at December 31, 2013.
Long-term obligations were $6.3 million, including $3.4 million of accrued pension liability; $1.1 million was current and $5.3 million long term. The company received $859,000 from an equipment financing arrangement. It had no borrowings under its $15 million uncommitted credit line, but the bank advised it would not provide advances unless it received and accepted specified company information.
Material changes and management commentary
- Revenue declined mainly because of reductions in e-book services for one significant client (about $1.6 million) and work for one non-e-book client (about $1.2 million); growth from other customers partly offset the decreases.
- Lower CS production headcount and productivity gains reduced direct costs, improving the cost ratio and gross margin despite lower revenue. Restructuring also reduced CS selling and administrative costs.
- IADS revenue fell sharply and its loss increased, reflecting lower revenue and operating leverage. IADS subsidiaries remain developmental, with minimal revenue and all fixed assets written off.
- Foreign-currency derivative changes contributed $655,000 of other comprehensive income in Q1 2014. This is not operating income; total comprehensive income attributable to Innodata was $839,000.
Outlook, risks and contingencies
Management expected to invest $1.5 million to $2.0 million per quarter in IADS in the immediate future and anticipated $3.0 million to $4.5 million of capital expenditures over the next 12 months. Management said cash and internally generated funds were expected to meet financial needs for the next 12 months, but indicated IADS investment could be curtailed if funding proved insufficient and outside financing was unavailable on acceptable terms. Of the $29.2 million cash balance, $23.5 million was held by foreign subsidiaries and management intended to reinvest those funds abroad; repatriation could trigger U.S. federal income taxes.
Key stated risks include client concentration, at-will and project-based contracts, clients reducing or canceling work, failure to replace projects, wage inflation, quarterly project-startup variability, competition and continued IADS losses. One client generated 19% of Q1 revenue and another 12%; four clients accounted for 55% of receivables. Foreign clients generated 43% of revenue. The $15 million credit line was due to expire in June 2014 and was not a dependable source of liquidity.
Tax exposures included $2.2 million of unrecognized tax benefits. The filing describes ongoing Indian and Philippine tax matters and says outcomes for certain proceedings cannot be determined. A favorable Indian audit outcome led to reversal of a $722,000 provision in Q1. A Philippines labor case seeks approximately $8.0 million in back wages and benefits; management, based on legal counsel, believed recovery against Innodata was unlikely. Separately, adverse outcomes in other proceedings beyond recorded amounts were considered reasonably possible up to approximately $250,000 in aggregate.
Important facts for investors to verify
- Whether revenue and client volumes stabilized after the year-over-year decline, especially for major CS customers.
- Whether CS margin improvements continued and whether they offset the effect of lower revenue.
- IADS revenue, losses, asset position and actual investment needs versus the stated quarterly range.
- Availability of liquidity after the bank’s credit-line notice, including the location and potential tax cost of foreign-held cash.
- Receivables concentration, collections and DSO trends, along with the status of significant tax and legal contingencies.
- The performance and accounting impact of foreign-currency hedges and the company’s exposure to wage and currency movements.